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Casey Hyunh is trying to value the stock of Resources Limited. To easily see how a...

Casey Hyunh is trying to value the stock of Resources Limited. To easily see how a change in one or more of her assumptions affects the estimated value of the stock, she is using a spreadsheet model. The model has projections for the next four years based on the following assumptions. • Sales will be $300 million in Year 1. • Sales will grow at 15 percent in Year 2 and 5 percent in Years 3 and 4. • Operating profits (EBIT) will be 17 percent of sales in each year. • Interest expense will be $10 million per year. • Income tax rate is 30 percent. • Earnings retention ratio would stay at 0.60. • The per-share dividend growth rate will be constant from Year 4 forward, and this final growth rate will be 200 basis points less than the growth rate from Year 3 to Year 4. The company has 10 million shares outstanding. Hyunh has estimated the required return on Resources’ stock to be 13 percent. A. Estimate the value of the stock at the end of Year 4 based on the above assumptions. B. Estimate the current value of the stock using the above assumptions. C. hyunh is wondering how a change in the projected sales growth rate would affect the estimated value. Estimate the current value of the stock if the sales growth rate in Year 3 is 10 percent instead of 5 percent.

Solutions

Expert Solution

1-
Year 1 2 3 4 5
sales =sales in year 1*(1+growth rate) 300 345 362.25 380.3625
EBIT-17% of sales 45 51.75 54.3375 57.05438
less interest 10 10 10 10
EBT 35 41.75 44.3375 47.05438
less tax-30% 10.5 12.525 13.30125 14.11631
net income 24.5 29.225 31.03625 32.93806
Expected dividend-40% of net income 9.8 11.69 12.4145 13.17523 13.175*1.02 13.4385
terminal value of equity in year 4 expected dividend in year 5/(required rate of return-growth rate) 13.44/(13%-2%) 122.12
value of stock at the end of year 4 terminal value of equity/no. of stock outstanding 122.12/10 12.21
2-
Value of stock-Today
Year 1 2 3 4 4
cash flow 9.8 11.69 12.4145 13.17523 122.12
present value factor at 13% =1/(1+r)^n r=13% 0.884956 0.783147 0.69305 0.613319 0.613319
present value of cash flow = cash flow*present value factor 8.672566 9.154985 8.603871 8.080612 74.8974
value of equity =sum of present value of cash flow 109.41
value of stock per share-Today value of equity today/no.of stok outstanding 109.41/10 10.94
3-
If sales growth rate is 10% in year 3
Year 1 2 3 4 5
sales =sales in year 1*(1+growth rate) 300 345 379.5 398.475
EBIT-17% of sales 45 51.75 56.925 59.77125
less interest 10 10 10 10
EBT 35 41.75 46.925 49.77125
less tax-30% 10.5 12.525 14.0775 14.93138
net income 24.5 29.225 32.8475 34.83988
Expected dividend-40% of net income 9.8 11.69 13.139 13.93595 13.9359*1.02 14.21462
terminal value of equity in year 4 expected dividend in year 5/(required rate of return-growth rate) 14.2146/(13%-2%) 129.22
Value of stock-Today
Year 1 2 3 4 4
cash flow 9.8 11.69 13.139 13.93595 129.22
present value factor at 13% =1/(1+r)^n r=13% 0.884956 0.783147 0.69305 0.613319 0.613319
present value of cash flow = cash flow*present value factor 8.672566 9.154985 9.105986 8.547179 79.25531
value of equity =sum of present value of cash flow 114.74
value of stock per share-Today value of equity today/no.of stok outstanding 114.74/10 11.47

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